Climate finance negotiations have been surrounded by multiple need estimates as well as diverse commitments to address the same. While the actual realisation of some of those commitments remains yet to be seen, what can be clearly observed is the rising magnitude of the global climate finance need. The latest estimates for climate finance flows in 2019-20 reveal that the required increase in annual climate finance is to the tune of a minimum of 590 per cent to meet different agreed-upon climate objectives by 2030 and to avert the impacts of climate change. Supplying such high requirements would imply a larger role for the private sector. While greater private sector channelisation of climate finance is something which has been stressed at multiple fora, the sector is due to play a vital role in expanding the horizons of climate investment on par with its capabilities. An iteration of one of the most discussed private sector instruments, sustainable foreign direct investment (FDI) or ‘green FDI’ has a high ability to support the mobilisation of a significant share of this huge climate financing need.
What is green or sustainable FDI
No one knows…at least to the extent of having an official global definition! Similar to an official definition-less concept of climate or green finance, there exists no agreed-upon global definition of sustainable or green FDI. There have however been various attempts to analyse what should or should not be included under the concept [some of these include, UNCTAD World Investment Report 2010, UNCTAD Roundtable Note (2008), OECD Policy Framework for Investment (2015), OECD Working Paper: Defining and Measuring Green FDI (2011) etc.]. Broadly, sustainable or green FDI signifies an FDI investment with an additional objective of supporting environmental and climate goals, including protection and enhancement of resiliency as well as avoidance of negative impacts on the environment.
For a long time, FDI has been a voluminous source of international financing. It is a crucial factor in investment baskets particularly for developing countries, going beyond the scope of being a simple international flow supporting financial development, to having an important social and environmental impact as well. The latest numbers from the 2022 UNCTAD World Investment report indicated an increase in global FDI flows by 64 per cent, from the exceptionally low level in the pandemic-affected year of 2020. Sustainable FDI forms one of the many components in total FDI flows. In fact, 2021 witnessed an increase in climate investment as well with an acceleration in flows to sectors relevant for sustainable development goals (SDG). There exists immense potential to tap on the ‘greener’ version of FDI to not only help governments channelise private finance participation but also to further the sustainable development agenda for all.
Scaling up sustainable FDI
The FDI landscape in general has been dealing with persistent issues ranging from investors’ confidence to bureaucratic hurdles in host countries for a while now. These issues hold same or perhaps greater pertinence for the greener portion of this flow. Risk appetite of investors is shrinking or increasingly getting restricted. Even though the total FDI flows have witnessed an increase; in the post-pandemic recovery period along with impacts felt from the war in Ukraine, it is expected that the risk appetite of investors will get more restricted. This in turn will have a significant effect on ensuing FDI flows, and sustainable FDI may take a hit as well.
Further, the lack of an agreed-upon definition harms the flow of green FDI more than is apparent. The definitional challenge makes way for the possibility of ‘green washing’ by self-styled green companies. It restricts the proper assessment of progress towards environmental and sustainable objectives as well as hampers the engagement of investors and government partners willing to advance green projects.
Green or sustainable FDI, like any other innovative financial instrument thus also requires the push to gain momentum as a widespread means of climate financing. The push needs to initiate first at the country level. There are a number of initiatives that could be considered by national governments to steer greater foreign climate funding including green FDI. First and foremost, there is a critical need for countries to directly reflect the choice of sustainable development in their investment policies and strategies. A mix of green bonds, green credits, etc. in the investment portfolio helps not just to attract more foreign investors seeking green outcomes of their investments, but also aids in building investor confidence in the prominence of sustainable investment in the nation. Second, an outright declaration of sustainable investment agenda under an investment facilitation framework will help to further bolster investor credence. Going beyond the singular focus of simply increasing FDI flows with perhaps an indirect small contribution to sustainable development, there is a need to include provisions in the investment portfolio of countries that command direct contribution to sustainable development, thereby encouraging green FDI investments. Defined sustainability requirements of FDI such as local linkages, low carbon footprint, etc., will help bridge the information gap on the role of investor’s possible investments in prioritised green segments of the country. At the same time, additional sustainability requirements might then necessitate the country to offer several other benefits to foreign investors as well, to balance the maintenance of interest between the two parties. Finally, a quick approval and grievance redressal mechanism will assist in easing out operational difficulties for investors. For instance, the ‘single window clearance’ program for FDI as adopted by India has immensely helped the country to attract greater amount of FDI and land a place among the top 10 economies for FDI inflows in 2021. These initiatives hold much more relevance for developing countries, as usually they are the ones seeking greater inward FDI flows caught in the middle of achieving developmental goals and maintaining environmental commitments.
While the countries need to work at their level to attract greater green FDI flows, the G20 platform can also help to further the green financing agenda. G20 forms a group of the most influential economies and is in a strategic position to impact global investment strategies and decisions. The group has in fact, always had the agenda of green financing on its priority list. The 2017 summit under German presidency witnessed the launch of the GreenInvest platform, which focused on providing a level ground to developing countries to mobilise green finance and sought to accelerate green investments. One of the focus areas under the platform was also recognised to be the need to accelerate the agenda of green FDI. Building up to the previous efforts, G20 could now stress on and promote the adoption of a broader set of standards for green FDI in the member countries. This could then facilitate the movement towards the development of a universal system for understanding and thereby promoting green FDI. However, while this would introduce some extent of transparency in the system, it would still cater to augment only the supply side. The demand side of finance also needs to be tapped, for which the G20 could facilitate the creation of a separate vertical on capacity building for project preparation and documentation for all green finance ventures. This would aid the demanding set of countries to learn and sharpen their capabilities to prepare for greater augmentation of green financing. An institutional arrangement will help to cater to investor demands as well as facilitate international policy coordination on financing for climate action.
Conclusion
In the wake of the pandemic, it is much more relevant now than ever to ‘build back better and greener’. It is necessary to recognise the role of different innovative climate financial instruments to reduce reliance as well as to move beyond the traditional set. Expanding the role of green FDI in raising climate finance is crucial. It then requires comprehending the constraints to the flow and the responsibility that it commands from all stakeholders.
Recognition and re-iteration of the importance of green FDI at the G20 as a crucial climate financing instrument will contribute towards the global sustainable development agenda immensely. With G20 bringing together key economic players having dominant shares in outward FDI flows, the platform can serve as the harbinger of change towards aligning developmental and economic recovery with environmental and sustainable needs.
(Views expressed are the author’s own and don’t necessarily reflect those of ICRIER.)
